Boosting Returns With Biotech

Biotechnology & healthcare has been one of the best performing sectors of the last decade. And with the average age of the developed world’s population continuing to increase, many people think this trend could continue for some time yet.

The best performing sectors

So what sort of outperformance are we talking about?

Here’s a breakdown of the MSCI World Index over the last decade. It’s ranked by average returns in US dollars per year:

Industry	Last decade, pa returns	Proportion of world index
Technology	16.4%	16.3%
Consumer discretionary	14.8%	10.5%
Healthcare	13.2%	12.6%
Industrials	11.9%	11.2%
Consumer staples	11.0%	8.5%
Real estate	10.8%	3.2%
World	10.7%	–
Financials	8.5%	15.8%
Communications	8.0%	8.3%
Utilities	* 7.0%	3.3%
Materials	6.3%	4.6%
Energy	3.5%	5.7%

* For some reason, I could only get a price return figure for the MSCI World Utilities sector. This was 3% for the last decade, so I added an extra 4% to estimate the total return.

It’s no surprise to see the likes of technology and consumer discretionary at the top, or indeed materials and energy at the bottom.

Of course, chasing a hot sector can be a poor strategy. Since it was created at the end of 2000, the MSCI Technology index has performed only a little bit better than world markets (5.5% pa versus 5.2%), so it was a massive underachiever from 2001 through to 2009. No prizes for guessing why!

The MSCI Healthcare index is a little older and it has returned 10.9% a year since the end of 1994 compared to 7.7% for global markets.

Healthcare is a specialist subject

Funds like Allianz Technology, Polar Capital Technology, Fundsmith, Lindsell Train Global and Scottish Mortgage that have big weightings in technology and consumer brands have among the top performers this past decade.

However, most of this illustrious group doesn’t particularly specialise in biotechnology & healthcare. I think Scottish Mortgage (18%) and Fundsmith (24%) have the largest weightings.

But there are six investment trusts to choose from if you want to ramp up your exposure a little bit more.

Biotech, pharma, and healthcare

Let’s look at a further sector breakdown before we talk about the six individual trusts.

The healthcare industry has a number of very different sub-sectors:

The difference between pharmaceuticals and biotechnology isn’t always straightforward.

My googling skills inform me that biotech is something derived from a living organism whereas pharmaceuticals are artificially synthesised from chemicals. The former tends to consist of larger and more complex molecules.

On a corporate basis, biotech companies tend to be younger, smaller, and more research-based, while pharmaceutical firms specialise more in manufacturing, distribution, and marketing.

The line is increasingly becoming blurred, with some companies doing a bit of both and they are sometimes referred to as biopharma.

Between them, biotech and pharma (drug development in other words) account for just over half the healthcare index. Equipment and the provision of healthcare services are the other main areas.

On a country basis, the US leads the way with 69.5%. That’s a little bit higher than its 62.7% weighting in the MSCI World Index.

Switzerland’s 9.2% weighting is largely down to it being home to two of the largest companies in the sector, namely Novartis and Roche.

A little about the industry

I would certainly not claim to be anything like a sector expert, but here’s a very high-level view of the industry, mostly relating to the drug development sub-sector.

I’ve used the MSCI World Healthcare index throughout this piece as a comparator for returns. For drug developers, the NASDAQ Biotechnology index is also a useful benchmark.

Drugs are very expensive to develop, with the costs typically coming to a few billion pounds just to develop a single product. And the vast majority of treatments never make through to approval by key regulatory bodies (the Food & Drug Administration in the US and the European Medicines Agency).

Trials go through three main phases:

• Phase 1 – tested on a handful of people, mainly to assess a drug’s safety;
• Phase 2 – a few dozen people, to see whether the drug actually works plus a bit more on safety; and
• Phase 3 – hundreds of people to test dosage levels, check for side effects, and to compare against existing treatments.

The further a drug gets, would you believe, the greater its chance of success.

Only around 10% of drugs entering Phase 1 end up getting approved with Phase 2 being the stage that most drop out. Regulators in the US have historically approved 85% of drugs that have completed all three Phases.

When the results of each stage or final approval are announced, individual company share prices can soar or plunge, especially those of smaller companies with just a few drugs in development.

A record number of treatments, 59 in total, were approved in the US in 2018. The average for the past couple of decades is roughly 30. That’s partly a factor of the increased number of products in development — currently around 3,000 late-stage products versus some 2,000 a decade ago.

Treatments are protected by patents for a number of years, allowing the companies that produced them a period of exclusivity to recoup their investment.

Once a drug comes off patent, other companies are free to copy them (called generic drugs). For example, ibuprofen is a generic drug, whereas Advil and Nurofen are branded versions.

Drug costs are obviously a very politically sensitive issue, and they can vary widely from country to country, as does the mixture of private and public healthcare provision.

Communicable diseases are generally in decline, due to better living conditions and wider access to healthcare. But cancer, heart disease and diabetes are on the rise as we live longer (but not healthier).

Gene therapy, such as CRISPR, which essentially allows scientists to cut out and replace deficient pieces of DNA could be the next big thing. But there are still many ethical concerns, disputes over patents to the technology, and doubts as to how effective it is.

When it comes to global healthcare expenditure, the US dominates at about 45%. That’s twice the size of Western Europe. However, despite its high spend per person, the US is generally regarded as having a very ineffective service in terms of outcomes and general access.

Deloitte reckons total healthcare expenditure could hit $10 trillion by 2022, representing annual growth of 5.4% from 2018-22. Interestingly, that’s a sizeable step up from the 2.9% a year for 2013-17.

Our six runners and riders

Here are some selected stats for the investment trusts that specialise in biotechnology and healthcare:

Name	Management group	Ticker	Total assets	(Discount)/ premium	Holdings	Gearing	NAVTR 1yr	NAVTR 3yr	NAVTR 5yr	NAVTR 10yr	Yield	Launched	Charge incl. perf. fee (%)
BB Healthcare	Bellevue Asset Management	BBH	£638m	2.7%	* 35	12%	6%	–	–	–	2.8%	2016	1.2%
Biotech Growth	Frostrow Capital/OrbiMed	BIOG	£425m	(8.9%)	47	9%	-5%	19%	62%	554%	–	1997	1.1%
International Biotechnology	SV Health Managers	IBT	£245m	0.0%	78	0	0%	28%	104%	429%	4.3%	1994	1.2%
Polar Capital Global Healthcare	Polar Capital Holdings	PCGH	£330m	(7.7%)	30	7% through ZDPs	5%	19%	62%	–	2.1%	2010	1.0%
Syncona	Syncona Investment Managers	SYNC	£1,418m	11.2%	8	0	1%	65%	82%	–	1.0%	2012	1.9%
Worldwide Healthcare	Frostrow Capital/OrbiMed	WWH	£1,494m	0.5%	63	0	0%	29%	107%	450%	1.0%	1995	0.9%

* BB Healthcare has a stated maximum of 35 holdings when fully invested but I couldn’t find a complete current list.

It’s impossible to do justice to all six of these in a single article, so I’ll just concentrate on some high-level observations.

There are three veterans, all launched in the 1990s, and three debutants from the 2010s.

Worldwide Healthcare, which I held when it was known as Finsbury Worldwide Pharmaceutical in the 1990s, has been the largest fund most of the time, although Syncona is running it close.

Most of these funds are run by institutions who specialise in the sector, so there is a notable absence of the big fund groups such as Baillie Gifford, JPMorgan, Janus Henderson, Standard Life Aberdeen etc that dominate many of the other sectors. OrbiMed manages two funds in the sector, Worldwide Healthcare and Biotech Growth.

Discounts, gearing and costs

There is a mixture of discounts and premiums although most funds have seen their share prices outperform their net asset value over the last decade.

Worldwide Healthcare has gone from a 10% discount to 0% while International Biotechnology managed to eliminate a 20% discount after changing its dividend policy to pay out 4% of net assets each year. BB Healthcare has a similar dividend policy but it uses 3.5% of net assets.

International Biotechnology bases its dividend on its net asset value on 31 August each year. As its current net asset value is a bit lower than it was on 31 August 2018, its historic yield in the table above is a little over 4%.

BB Healthcare paid out 4p last year, which represents the yield of 2.8% shown in the table above. But it has declared a new target of 4.85p (a prospective yield of 3.5%) based on its net asset value as of 30 November 2018.

Only some of these trusts use gearing at the moment including Polar Capital Global Healthcare which has net gearing of 7% due to some zero dividend preference shares that are due to be repaid in 2022.

There is not a lot between five of the six when it comes to charges, although BB Healthcare is the only one that does not charge a performance fee.

The performance fees are generally 10-15% of any benchmark outperformance, although some set their hurdle rates as high as the healthcare index plus 1.5%.

Syncona is the standout on overall costs at 1.9% but that’s because it is much more actively involved in founding and developing the companies that it invests in. It was formerly the investment arm of the Wellcome Trust and merged with the Battle Against Cancer Investment Trust in 2016.

It’s also worth noting that Syncona currently has almost 70% of its assets in cash after two of its biggest holdings (Blue Earth and Nightstar) received bids in recent months. And just over 20% of its assets are represented by a 31% holding in Autolus (which floated last year and in which Neil Woodford is a big investor).

This has seen Syncona’s premium to net assets shrink from 50% in March to a more sedate 11%. I suspect it could be a while before this cash is reinvested, so this might act as a drag on Syncona’s returns in the meantime.

Performance

Global markets have returned around 80% the past five years, so the trusts as a group have pretty much matched that (as has the MSCI Healthcare index).

Over the last ten years, though, we can see some truly impressive numbers from the three trusts that have been around that long.

Performance over the year or so has been much more subdued. The sector has bounced back from the depths seen at the end of 2018, but not nearly as strongly as technology.

Portfolio breakdown

On a crude level, we can split these trusts into two groups: those that just invest in drug developers (Syncona, International Biotechnology and Biotech Trust) and those that also invest in wider healthcare products and services as well  (the three with Healthcare in their name).

Even within these groupings, there can be some big differences. Most of these trusts break down their holdings by sub-sector and by size of company.

This is Worldwide Healthcare, which likes emerging biotech and emerging markets but is less keen on the big pharmaceutical companies and healthcare services:

This is Polar Capital Global Healthcare, which is much more biased to equipment mostly at the expense of big pharma:

Most of these trusts run pretty concentrated portfolios, much more so it would seem than the technology funds I looked at a few months ago.

Syncona just has 8 investments, with one of those dominating, plus that big pile of cash. Polar Capital Global Healthcare and BB Healthcare are the next most concentrated.

Worldwide Healthcare, given its larger size and breadth of sectors, is unsurprisingly one of the best diversified. But it is International Biotechnology, the smallest of the six, that actually has the largest number of holdings.

Summing up

I still like the long-term prospects for this sector. Along with technology, it’s one of the sectors I’m keen to invest a little bit more in.

Certainly, biotech stocks do seem to be attractively valued right now:

I got pretty close to starting a position in International Biotechnology when I was deciding where to reinvest the proceeds of my City Of London disposal a few weeks ago.

I saw its team present at the recent Mello conference and they certainly impressed. Carl Harald Jansen came on board as manager in 2013 and that does seem to have kicked things up a gear. The high frequency with which its portfolio is turned over is giving me a little pause for thought.

Polar Capital Global Healthcare was at the same event but didn’t come across as well I thought. Admittedly, their presentation was a bit more about industry trends, but their portfolio seems more focused on what I believe to be slower growth parts of the sector.

However, I believe the same team runs the open-ended Polar Capital Healthcare Opportunities fund and that has produced an impressive 109% return over the last five years and roughly 500% over the last ten.

Syncona looks very interesting, or least it would do if I was a little bit younger! In terms of investing strategy, it’s by far the highest risk of all the six trusts. Oddly, its temporarily large cash balance means it’s probably the lowest risk until it gets deployed in a meaningful way.

The team behind BB Healthcare also run BB Biotech AG, a well-regarded Swiss investment company that has been around since 1993. I’d probably want to dig into that fund’s record before making any decision on this one.

That leaves the two OrbiMed funds. I know there was a kerfuffle with one of OrbiMed’s co-founders last year who had been the portfolio manager for Worldwide Healthcare. But I think I’d still give that the nod over Biotech Growth as I’d probably want two funds to spread my bets a bit and have one biotech-only and one with a broader remit.

I would probably have to sell something to invest a meaningful amount in this sector, so I suspect it will a little while before I pull the trigger on any of these.

   

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Disclaimer

Please note that I may own some of the investments mentioned above -- you can see my current holdings on my portfolio page.

Nothing on this website should be regarded as a buy or sell recommendation as I'm just a random person writing a blog in his spare time and I am not authorised to give financial advice. Always do your own research and seek financial advice if necessary!

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